Process Costing
When is process costing appropriate?
How does it differ from Job Order Costing
In some sense, Job Order Costing is focused on output measures and
Process Costing is focused on input measures.
Homogeneity or similarity of costs across batches
To visualize it: think of batches of inseparable products such as petrol,
flour, paper.
It could be computers, though. Even though they are separately
identifiable, for the most part the costs are homogenous (the same).
Example 1
Moravia Company process and packages cream cheese. The following data
have been compiled for the month of April. Conversion activity occurs
uniformly throughout the production process.
Work in Process April 1 – 10,000 units
Direct material: 100% complete, with a cost of $22,000
Conversion costs: 20% complete, with a cost of $4,500
100,000 units were started during April and 80,000 were completed.
Work in Process April 30 – 30,000 units
Direct material: 100% complete, with a cost of ??????
Conversion costs: 33% (1/3) complete, with a cost of ??????
Costs incurred during April:
Direct materials costs of $198,000 and conversion costs of $158,400 were
incurred during April.
What is the cost of goods transferred out and the cost of goods in ending
inventory (the question marks above)? (Note: there are two approaches,
Weighted Average and FIFO – we will only look at weighted average unless
we get really bored)
First, we look at total units. I like to get a thorough understanding of units.
I do this by figuring out what the number of units started and completed
this period were:
Here is a helpful tool:
Every unit that we worked on at all this period was either in beginning
inventory or we started it this period. Conversely, every unit that we
worked on was either finished or it is in ending inventory. These two must
be equal.
BI
10,000
EI
30,000
+ Units started
100,000
+Units completed
80,000
TOTAL
110,000
TOTAL
110,000
So, there are 100,000 units started, 30,000 of them are not completed.
70,000 units must, therefore have been started and completed this period.
In addition, 80,000 units were completed this period, but 10,000 of them
were started in the previous period (they were in beginning inventory).
Hence there were 70,000 units started and completed this period. This
equality follows directly from the previous one above.
We now introduce the concept of an equivalent unit. This is why I say we are
costing inputs here. We will figure out how much a unit of input (materials
or conversion) costs and then use that to allocate costs to Finished Goods
Inventory and Work-In-Process.
Instead of doing 20% of the conversion work on all 10,000 units that are in
beginning inventory, we could have focused our efforts and actually
completed 2,000 of the units (and not started the others at all). In that
sense, we did work equivalent to 2,000 units worth.
For direct materials, we had put 100% of the materials for the 10,000 units
into process at the beginning of the process (this is common, you frequently
start with all of the materials in process as you start a batch). No materials
were added during the period for these 10,000 units. On the other hand, we
started 100,000 units this period and we added ALL of the materials that go
with those 100,000 units (how do I know that?).
In beginning inventory, we had 10,000 units worth of materials inputs, but
only 2,000 (equivalent) units worth of conversion inputs. Those will be our
equivalent units in beginning inventory.
Now that we understand how equivalent units work, lets see how we use
them. What we really want is a cost number for an equivalent unit of
material and an equivalent unit of conversion. We will be able to use them
like we used the cost estimates in the Peterson’s Catering Company problems
(2, 3, and 4 from yesterday). We will multiply these unit costs by the
number of equivalent units in ending inventory (of materials – and of labor –
separately) to get the cost of ending inventory. We will also do the same
thing with goods transferred to FGI (Finished Goods Inventory).
We are going to average unit costs over both periods (last period and this
period). The total costs incurred over the two periods are given below:
Beginning Inventory costs
Costs incurred THIS period
Total
Direct Materials Conversion
Total
$
22,000 $
4,500 $
26,500
198,000
158,400
356,400
$
220,000
$
162,900
$
382,900
These costs correspond to the following equivalent units:
Units Completed
Equivalent Units in EI
Total
1.
2.
Direct Materials
80,000
30,000
110,000
Conversion
80,000
10,000
90,000
Why did we add Units Completed to Equivalent Units in EI (Ending
Inventory)?
Where did the 10,000 Equivalent Units of Conversion come from?
Let’s answer the second question first – it’s easiest. There were 30,000
units in EI and they were 100% complete in terms of the materials. In other
words, all of the materials had been put into process for those units. But
only 1/3 (33%) of the conversion work had been done. So 1/3 of 30,000
total units is 10,000 equivalent units.
Now, let us answer the harder question. The costs above are the costs in
beginning inventory plus the costs incurred during April. The first thing we
did during April was finish the beginning inventory units. Then we started
some units – some of which we finished and some we did not. The costs
incurred this period went to 3 things: finishing beginning inventory, starting
and finishing some units (70,000), and starting the ending inventory units.
Add these costs to beginning inventory costs and you have the costs of the
units completed (Beginning Inventory + Cost to complete + Cost of units
started and completed this period) AND the costs of EI. Did that answer it
– or is it still a circle?
The cost of an equivalent unit are computed below. This computation is
obvious:
Costs
Equivalent Units
Cost per Equiv. Unit
Direct Materials
$
220,000 $
110,000
$
2.00
Conversion
162,900
90,000
$
1.81
To compute the cost of goods transferred out, we take the number of units
transferred out (notice that they are all COMPLETE) and multiply by the
total Cost per Equivalent Unit = $3.81.
This gives us 80,000 * $3.81 = $304,800.
The cost of goods in Ending Inventory is computed below:
Equivalent Units in EI
Cost per Equiv. Unit
Cost
Direct Materials
30,000
$
2.00 $
Conversion
10,000
1.81
$
18,100.00
60,000.00
$
Total
$ 78,100.00
Notice that if you add the $78,100 to the $304,800, you get the total costs
of $382,900.
Example 2
Frito-Lay, Inc., manufactures convenience foods, including potato chips and
corn chips. Production of corn chips occurs in four departments: cleaning,
mixing, cooking, and drying and packaging. Consider the Drying and Packaging
Department, where direct materials (packaging) are added at the end of the
process. Conversion costs are added evenly during the process. Suppose the
accounting records of a Frito-Lay plant provided the following information
for corn chips in its Drying and Packaging Department during a weekly
period:
Beginning work in processa
Transferred-in during the
week from Cooking
Department
Completed during the week
Ending work in processb
Costs added during the
week
a
Physical
Units
(Cases)
1,250
5,000
Transferred
-In
Costs
$29,000
Direct
Materials
Conversion
Costs
$0
$9,060
$25,200
$38,400
5,250
1,000
$96,000
Degree of completion: transferred-in costs, 100%; direct materials, ?%; conversion costs,
80%.
b
Degree of completion: transferred-in costs, 100%; direct materials, ?%; conversion costs,
40%.
Requirements: Compute the cost of goods completed and transferred out
using the Weighted-Average method of process costing.